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Oil Prices 2016: What to Expect

If 2015 is any indication, expect the unexpected when it comes to oil prices in 2016.

Heading into 2015, there was a general consensus among analysts that oil prices would be weaker initially in 2015 before improving toward the end of the year. In fact, about this time last year, the U.S. Energy Information Administration, or EIA, forecast an average price for crude at around $75 per barrel, with a potential range anywhere between $125 to $50. Clearly, this wasn't the chart it expected to see at the end of the year:

That chart shows just how hard it is to predict what oil prices will do. To be fair, though, there were four major factors that weighed on the price of oil in 2015:

U.S. oil producers proved to be much more resilient than expected, with most handily exceeding initial production guidance. Devon Energy(NYSE:DVN), for example, now expects its oil production to grow 31% to 33% year over year, which is above its initial guidance of 20% to 25% growth, and in spite of spending $500 million less than its initial guidance.

The Iranian nuclear agreement has the potential to unleash upwards of 1.5 million barrels per day of new production in the near future.

Knowing the unknowable makes it tough to predict what oil prices will do next. That said, this has never stopped analysts from trying in the past and it won't prevent them from putting out their 2016 projections. So, without further ado, here's what analysts currently think oil prices will do in 2016.

Oil prices in 2016The EIA recently put out its short-term energy outlook, which forecasts that the global oil price benchmark Brent will average $56 per barrel in 2016, while the U.S. oil benchmark WTI will trade at a $4-per-barrel discount to Brent, or at $52 per barrel. Both numbers are quite higher than the current oil price, largely due to the belief that U.S. oil production will decline from its average rate of 9.3 million barrels a day in 2015 to 8.8 million barrels per day in 2016, helping to ease the supply glut.

The EIA is not alone in its $50-a-barrel forecast range. Barclays, for example, recently revised its estimate down by $3 per barrel, but still sees WTI averaging $56 per barrel with Brent projected to average $60 per barrel. On the lower end is credit rating agency Moody's, which now sees WTI averaging just $40 a barrel and $48 for Brent after it recently slashed its forecast from $43 and $53 for WTI and Brent, respectively.

Overall, $50 oil is the general consensus, however, there are other analysts warning that oil could still have a lot more downside before it recovers. Goldman Sachs, for example, has warned that oil could fall to as low as $20 per barrel if oil storage capacity fills to the brim. That being said, that price represents its worst-case scenario and not the bank's base case, which is that oil will average around $45 through the next year.

Image source: Flickr user Derek Gavey.

What this forecast means for oil companiesMost U.S. oil companies would welcome a return to a $50 crude price because that's just high enough for them to make it through 2016 without having to make any real drastic changes. Bakken shale producers like Continental Resources(NYSE:CLR) and Whiting Petroleum(NYSE:WLL) are among those banking on a $50 oil price in 2016. For Whiting Petroleum, a $50 oil price would enable it to generate the roughly $1 billion in cash flow it needs to drill just enough wells to maintain its current production rate at around 160,000 barrels of oil equivalent per day, or BOE/d.

Continental Resources, likewise, could be cash flow neutral at a $50 oil price in 2016 because that price would provide the roughly $1.5 billion in cash flow it needs to maintain its production at about 200,000 BOE/d. Meanwhile, Devon Energy would do even better at a $50 oil price, with the company currently estimating that it could deliver a low-single-digit oil production growth rate if oil were around that price.

All that being said, a $50 oil price in 2016 could spell doom for deeply indebted oil companies, especially if oil dips toward $20 a barrel and stays there for a while before eventually recovering. That's because these companies have burdensome debt balances as well as fewer lucrative drilling locations.

Investor takeawayAt the moment, the general consensus is that oil will eventually recover and average around $50 a barrel for 2016. At this point, a recovery to that level would be welcome news for many producers given that that likes of Devon Energy, Continental Resources, and Whiting Petroleum would still be able to function at that price. Still, the overarching concern is the downside risk, especially given that oil prices spent most of this year below the grizzliest of bear cases. It's that downside risk that oil companies and investors need to steel themselves for, given that analysts might not be able to see very clearly when they peer into their crystal ball.

Author

Matthew is a Senior Energy and Materials Specialist with The Motley Fool. He graduated from the Liberty University with a degree in Biblical Studies and a Masters of Business Administration. You can follow him on Twitter for the latest news and analysis of the energy and materials industries: Follow @matthewdilallo